Mahalo To Charging Order Issued Against Interests In Out-Of-State Non-Party LLCs

First Citizens Bank & Trust Company, Inc. ("FCB") won a Judgment of over $3 million against Mark Epstein, Andrew Kelly, and their company, Mahalo Investments III, LLC, in the State Court for Cobb County, Georgia.

During the post-judgment discovery of the debtors' assets, FCB learned that Epstein and Kelly owned interests in several other LLCs (the "LLCs") (which did not include Mahalo).

FCB then filed, in that same case and with the same case number, an Application for Charging Order against the debtors' interests in the LLCs. The Application was granted, and the Charging Order was issued.

The Debtors appealed the decision to the Georgia Court of Appeals, arguing that it was improper for the State Court that had issued the Judgment to also issue the Charging Order, and instead (they argued) FCB should have brought a separate action against the LLCs in whatever states those LLCs had been formed (the Opinion doesn't identify these states, and, as we shall see, it really doesn't matter).

As to limited liability companies, Georgia law provides:

On application to a court of competent jurisdiction by any judgment creditor of a member or of any assignee of a member, the court may charge the limited liability company interest of the member or such assignee with payment of the unsatisfied amount of the judgment with interest . . ..

[e]ach statute provides a means by which a judgment creditor or a partner may cause the diversion of monetary payments the partner expects to receive from the partnership to the partner's judgment creditor. Under both statutory schemes, the judgment creditor must initiate a collateral proceeding in which the creditor seeks a court order charging the debtor partner's partnership interest with payment of the unsatisfied amount of the judgment, or serves process of garnishment on the partnership. [] A judgment creditor must initiate the identical collateral proceedings in order to attach a lien to a chose in action.

(citations omitted).

So what is a "collateral proceeding"? The debtors argued that it meant that FCB was required to bring a new lawsuit against the LLCs whose membership interests were to be charged.

No, said the Court of Appeals, that language only means that the creditor must bring a "proceeding" in the sense of an Application for Charging Order in the State Court. There is utterly no need to initiate a new case involving the same parties; instead, the same court can issue the Charging Order after a hearing on the Application.

Appellants next argued that the Georgia State Court was not "a court of competent jurisdiction" because the Georgia State Court did not have personal jurisdiction over the LLCs whose interests were charged.

Of course, this argument presumed that the LLCs whose interests were to be charged were required to be made parties to the Application proceeding. Did they?

The debtors claimed so, arguing something like the LLCs were affected, directly or indirectly, by the Charging Order and so for that reason they needed to be named as party defendants.

The charging order provisions found in Georgia law (which largely track the RULLPA and ULLCA) are silent on the issue, i.e., they don't say whether an LLC (or LP) whose interests are charged must be made a party to the lawsuit.

The Court then noted that the holder of a Charging Order does not gain any management rights in an LLC or partnership, but only the right to distributions as they are made to the debtor/member's interest. Thus, and here is the most important part of the Opinion:

We glean from these provisions that the charging order is a mechanism by which a judgment creditor can attach a member's limited liability company interest to satisfy an unpaid judgment, but that the charging order does not permit the judgment creditor to replace the member or otherwise interfere in the governance of the limited liability company. Moreover, it is the judgment debtor's right to possession of distributions in the future that is essentially being levied or charged. Thus, from the limited liability company's standpoint, it is business as usual except that any distributions to the member subject to the charging order are diverted to the judgment creditor. Because the limited liability company has no right or direct interest that is affected by the charging order, we see no reason why it must be added as a party to the proceeding to obtain the charging order. See Bank of America, N.A. v. Freed, 983 N.E.2d 509, 520–521 (Ill.App.Ct.2012) (rejecting contention that a court must obtain jurisdiction over a limited liability company or partnership in order to charge a judgment debtor's distributional interest in those entities under similar charging order statutes). Thus, we hold that under Georgia's limited liability company act, it is only necessary for a court to have jurisdiction over the judgment debtor to have the authority to enter charging orders against the judgment debtor's interest.

Thus, the State Court's issuance of the Charging Order against Epstein's and Kelly's interests in the LLCs was quite appropriate, even if the Georgia courts did not have personal jurisdiction over those entities, and the Charging Order was affirmed.

ANALYSIS

Largely due to a poor understanding of what a Charging Order is and what it does (and does not do), many planners have taken as gospel the misstatements of the similarly misguided that if an LLC is formed in Jurisdiction A, then the courts of Jurisdiction B cannot issue a Charging Order against an interest in the LLC -- instead, a creditor must go to Jurisdiction B and start a new lawsuit there to try to get a Charging Order. The widespread belief in this theory, which is utterly devoid of anything approaching technical legal merit, is a stellar example of that phenomena so often found in asset protection planning of the blind leading the blind over the cliff.

Charging OrdersJDA

A Charging Order has the effect of placing a lien on the debtor/member's interest in an LLC, and has the effect of diverting to the creditor the payments that the debtor would have otherwise receive. The Charging Order is directly binding upon the debtor/member: If she receives money from the LLC that is subject to the Charging Order and does not immediately hand it over to the creditor, then she can be held in contempt. But as a lien, the Charging Order also effects the LLC once the entity has notice of the Charging Order, since the LLC risks violating the lien (just like any other lien) if it pays the debtor instead of the creditor.

Stated otherwise, an LLC that makes a distribution to the debtor with knowledge of the Charging Order lien is still liable to the creditor for that amount, and it is no defense that the LLC paid the debtor. Effectively, the LLC may have to "pay twice", i.e., pay the creditor and then seek a clawback of the distribution from the debtor. It is so much easier just to pay the creditor in the first place.

To create the Charging Order lien does not require that the LLC be a party to the lawsuit, since (as the Court here correctly notes), the LLC isn't materially affected by whom it makes a distribution too, other than the very minor clerical function of addressing the check to the creditor instead of the debtor/member. Presumably, the LLC was always going to make the same payment, just now it goes to a different place.

There is an entire industry that sells LLCs, and often does so by touting their state's "superior" Charging Order laws. For persons not actually living in that state, the hard truth is that this advantage is illusory since the state where they reside (or get sued) will simply apply its own Charging Order law. There may be other reasons that the grass is greener in some other state -- some states sell LLCs on the cheap -- but Charging Order protection is not one of them.

In many states, litigants and judicial officers alike are driven nuts because their states do not have procedures for Charging Orders, although Charging Orders are allowed by their LLC and partnership laws.

The various Uniform Acts relating to LLCs and partnerships (both GPs and LLPs) (which are sometimes collectively referred to as the "Harmonized Acts" because they have quite intentionally been made so similar), utterly fail to give anything like meaningful guidance to the Courts as to how to go about placing a Charging Order on a debtor/member's interest in an LLC or partnership. The Uniform Acts quite unhelpfully tell the Courts only that a creditor can get a charging order on such an interest, and then go dead quiet as to the myriad of issues that revolve around a charging order application. This leaves the state court judges, many of whom have never heard of a charging order or dealt with one before, trying to come up with an ad hoc procedure on the spot, and it leads to cases like this one.

Here the State Court got it exactly right, but in other cases litigants have not been so fortunate, and have had to waste a goodly amount of money to go to the Court of Appeals to come up with a fix, and usually remand the case back down to the trial court to try to get it right.

In the defense of these states' legislatures, litigation involving Charging Orders was not exactly a hotbed of activity until the present decade, there being only about 100 reported decisions on Charging Orders since the Uniform Partnership Act was first adopted in 1914. With LLCs exploding in popularity, however, we're now seeing a reported opinion on Charging Orders come down at the rate of about one per week. Stated otherwise, we've had more Charging Order opinions come out in the last five years than in the last 95 years; it is now a hotbed of litigation activity.

Fortunately, the vast majority of courts are getting the issues right even in the absence of guidance from legislatures on the Charging Order procedure.

I am licensed to practice law in Arizona, California, Nevada, Oklahoma and Texas. My practice is in the areas of creditor-debtor law and captive insurance. I am the author of books on asset protection, captive insurance, charging orders, and others. I have been an expert wi...